INTERNATIONAL POLICY CENTER
Gerald R. Ford School of Public Policy
University of Michigan
IPC Working Paper Series Number 100
Informality, productivity, and enforcement in West Africa: A firm level analysis
Nancy C. Benjamin
Ahmadou Aly MBAYE
June 24, 2010
Enforcement, Evasion and Informality: Theory and Practice
An International Conference in Honor of Katherine Terrell
Organized by
International Policy Center (Gerald R. Ford School of Public Policy, University of Michigan)
And
Cornell University
Ann Arbor, June 4-6, 2010
Informality, productivity, and enforcement in West Africa: A firm level
analysis1
By
Nancy C. Benjamin 2
And
Ahmadou Aly MBAYE 3
Abstract:
The informal sector accounts for a very large share in African economies, both in terms of GDP and
employment. However, most national surveys on the informal sector focus on labor market
issues and informal employment rather than the structure of informal businesses. And sample
designs are shaped by a narrow and in our view misleading definition of informality as small
scale individual or household firms. In this study, we use firm-level data collected on 900
formal and informal businesses in the capital cities of Benin, Burkina Faso and Senegal. The
information obtained from these surveys was complemented by more qualitative information
gathered from semi- structured interviews of major stakeholders in the three cities as well as
secondary data compiled from the national income accounts. Our study documents huge
enforcement problems leading to the emergence of large informal actors coexisting with
smaller informal businesses. In addition, we found an important difference in productivity
level between formal and informal firms in favour the former. We also show, however, that
the productivity gap is much smaller for large informal firms than for small informal firms,
again suggesting that large informal firms have the requisites to formalize but choose not to
do so.
1
The results we present in this paper are from a broader study on informality, the business climate and economic growth in West Africa,
funded by the Research Department of the World Bank. We are grateful to several anonymous Bank referees for helpful comments during
the design of the project. We also thank very much experts from UEMOA, and the national governments for helpful assistance during the
data collection phase. Dominique Haughton provided very helpful assistance during the sample design and data analysis phases. A
substantial contribution from Steve Golub is also acknowledged. Of course, the usual disclaimer applies.
2
The World Bank
3
University Cheikh Anta Diop of Dakar
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I. Introduction
It is common knowledge that the informal sector plays a central role in African economies,
accounting for a large share of GDP and an even greater share of employment. Some key
sectors of these economies are totally or partially under the control of the informal sector,
notably commerce, handicrafts, transportation, agriculture, and most of manufacturing.
Despite its importance, systematic studies of the informal sector in Africa are lacking and
some important dimensions are not well understood. In particular, much of the literature
ignores the major role played by what we call the “large informal” sector: firms with sales
that rival those of formal sector firms yet which operate in ways that are quite similar to small
informal operators. Our study is distinctive in distinguishing between three categories of
actors: formal firms, small informal firms, and large informal firms.
There have been few previous systematic data collection efforts that focus on informal firms
in Africa and those that do exist are not very comparable across countries. This is in part
because most national surveys on the informal sector focus on the labor market and informal
employment rather than the structure of informal businesses. Furthermore, sample designs are
shaped by a narrow and in our view misleading definition of informality as small scale
individual or household firms as defined in UN SNA (SNA, 1993), ignoring the “large
informal” sector.
In this study, we use firm-level data collected on 900 formal and informal businesses in the
capital cities of Benin, Burkina Faso and Senegal. The information obtained from these
surveys was complemented by more qualitative information gathered from semi- structured
interviews of major stakeholders in the three cities as well as secondary data compiled from
the national income accounts. The initial 900 interviews in the three cities were conducted in
2007. A second phase of more in-depth interviews with selected major stakeholders focusing
on the large informal sector was carried out in 2009.
The predominance of the informal sector in Africa, and the existence of large informal firms
in particular, highlight some major issues inhibiting African development. Despite its
importance the informal sector only contributes 3 percent of tax collections. The large
informal enterprises choose to remain in the ambit of the informal sector, even though they
meet all the criteria for formal status. The existence of these firms is a clear manifestation of
state failures in Africa: corruption, the governments’ weak enforcement capabilities, and
adverse business environments, all of which increase the costs and reduce the benefits of
operating formally. High taxes and onerous regulations on formal firms make formalization
unappealing while corruption and lack of enforcement enable politically well-connected and
influential actors to operate informally with impunity.
Our study also contributes to the literature on the relationship between informality and
productivity. Previous studies of developing countries have found that informal businesses are
less productive than formal ones (see for example Perry et al. 2009; Gelb et al. 2009); West
Africa is no exception, as we extensively document in this paper. We show, however, that the
productivity gap is much smaller for large informal firms than for small informal firms, again
suggesting that large informal firms have the requisites to formalize but choose not to do so.
The remainder of the document is organized as follows: the second section reviews the
significance of informality in West Africa. In a third section, our definition of informality as a
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continuum against the more standard binary formal/informal opposition is spelled out. The
fourth section documents the existence of large informal businesses in West Africa. The fifth
section discusses the relationship between informality and the business environment. The
sixth section reports findings on the relationship between informality and productivity. A
short concluding section follows.
II. The informal sector in West African economies: scope and major characteristics
The informal sector, however defined, occupies an important position in African economies,
as practically every study of the subject agrees. According to Schneider and Enste (2002), the
informal sector represents 10 to 20 percent of GDP in developed countries and more than a
third of GDP in developing countries. The ILO reports that the informal sector accounts for
48 percent of non-agricultural employment in northern Africa, 51 percent in Latin America,
65 percent in Asia, and 72 percent in Sub-Saharan Africa. Chen (2001) estimates that 93
percent of new jobs created in African during the 1990s were created by the informal sector.
Xaba et al. (2002) find that, while formal sector employment and output are stagnant at best,
informal sector employment and share in GDP are steadily increasing. Focusing on the rural
economy, Otsuka and Yamano (2006) report a non farm informal income share of 13 percent
in Ethiopia, 30 percent in Kenya and 38 percent in Uganda. Steel and Snodgrass (2008) report
that the informal economy accounts for 50 to 80 percent of GDP in Africa and as much as 90
percent of employment. Estimates show that the informal sector accounts for three quarters of
Ghana’s total income; in rural areas, this proportion reaches 90 percent (Canagarah and
Mazumdar 1999). In Burkina Faso, 80 percent of total employment is attributed to the
informal sector (Calves and Schoumaker 2004).
Some of the largest and fastest growing sectors of West African economies are informal:
transportation, hospitality, reproduction of musical CDs and tapes, carpentry, construction,
real estate, and especially retail and wholesale trade (Adams 2008; Lund and Skinner 2004;
Haan 2006). Verick (2006) finds that the retail sector is the largest locus of informal activities.
Similarly, Charmes (1993) found that 80.7 percent of businesses in Benin’s urban zones were
street vendors. According to a 1988 USAID survey (USAID, 1988), 72 percent of informal
activity in Senegal involves trade. The average size of informal business is 1.1 workers per
firm, i.e., one employee per firm (ILO 1995). The results from the second phase of the 1.2.3
survey (DPS, 2004), show that size of informal activity has increased but remains a very low
1.5 employees per firm. The 1-2-3 survey also found that 46.5 percent of informal activity is
in agriculture, while industry accounts for 30.6 percent, services for 21.3 percent, and 1.6
percent is attributed to fishing. These studies, however, defined informality as small firms,
and therefore ignored the large informal operators.
III. Informality as a Continuum
There are a number of possible definitions of informality and various studies have adopted
different concepts. Consequently, estimates of the informal sector’s magnitude vary greatly
depending on the chosen definition (Verick 2006). The most commonly-used criteria are: the
size of the business; registration with the government; and maintenance of honest and
complete accounts. Kanbur (2009) rightly argues that any researcher studying the informal
sector should begin by defining informality. In this section we review the main criteria for
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informality and show that each captures a part of the phenomenon. We then suggest that a
composite definition is more appropriate.
The size of activity criterion
Informal firms are often identified as having a small number of employees. The ILO’s
approach (ILO 2002), which defines an informal firm as an unregistered firm with no clear
line separating business activities and household activities, has been widely used. A further
qualifier is a lack of honest accounting statements. The only firms that fit these criteria are
family enterprises, classified as household enterprises in the United Nations’ system of
accounts (SNA 1993). According to this definition, the informal sector encompasses small
enterprises that employ fewer than ten employees and that are not registered with a given
administration. There are several ambiguities associated with this definition: a) The ILO sets
the recommended upper limit for number of employees at ten but individual countries have
leeway to set a different upper limit in their statistical definition of informal firms. Certain
countries choose an upper limit of 5 employees, whereas others chose either lower or higher
limits; b) Countries are also able to choose whether to include agriculture in informal
activities, along with unpaid domestic labour, individuals with a second job in the informal
sector, rural areas, minimum age, etc. Consequently, data on the informal sector is collected in
various ways and international comparisons are difficult.
Equally important, this definition excludes the large informal firms that are an important
segment of the informal sector. While it is certainly true that the vast majority of informal
firms in the countries that we are studying are small-scale or even miniscule enterprises, the
large informal firms account for a substantial share of informal sector output.
The registration criterion
Another commonly used criterion for defining informality is registration with a government
agency. A problem here is that there are multiple government agencies overseeing the private
sector (central or local administration, tax authorities, or others), and firms may register with
some but not others. Gelb et al. (2009) focused on registration with the tax authorities. On
this basis they distinguish between three types of enterprises: formal micro-enterprises (5 or
fewer employees), formal small enterprises (5 to 10 employees), and informal microenterprises (fewer than 5 employees). Note that this approach shows a further problem with
the size criterion: small and micro-enterprises can be formal. Indeed, among the seven
countries that the authors studied, the proportion of formal firms varied between a minimum
of 28 percent in Namibia and in Kenya, and a maximum of 54 percent in Uganda. La Porta
and Shleifer (2008) also make use of the registration criterion. According to them, a
distinction should be made between two categories of informal firms: those that fail to register
with the police, tax authorities, and other regulators, and those that are registered but
understate revenues. They therefore observe that the registration criterion alone is not
sufficient to qualify a firm as formal.
In our view, when studying francophone African countries, the registration definition
generally better captures informality than does the firm size criterion. Nevertheless, the
registration criterion poses serious operational problems when applied to West African
countries, for the reason noted above: data compilation on informal firms in these countries is
handled by agencies that often use different identifiers. Many firms are registered with some
4
agencies but not others. The street hawker who has no trading permit, but who is indexed in
the records of municipal services, might be classified as formal! One could use registration
with one particular government agency, e.g., the tax authorities, as the criterion for being
formal. However, many clearly informal firms are registered with the fiscal authorities.
Indeed, there are two types of fiscal regimes in WAEMU countries using the OHADA legal
system 4: regular business income tax and presumptive lump-sum tax. The first regime
requires reliable financial statements that enable calculation of taxable income based on
accurate reporting of profits or sales; the second regime is based on tax officials’ estimates of
the firm’s revenue and expenditures based on partial information, and a lump-sum tax is
levied. Thus, in WAEMU countries the important distinction is not whether or not firms are
registered with the fiscal authorities but rather what type of tax they are subject to.
The existence of honest financial statements criterion
The lack of accurate and complete books is also a fundamental distinguishing feature of
informality. Indeed, a characteristic of the informal sector is absence of transparency. The
majority of informal firms in West Africa lack regular and up to date books which makes
monitoring and taxation of these firms very difficult. In practice, however, this definition is
not easy to implement. How does one decide which types of financial statements to use and
whether or not they are accurate? Normally, the statements required by tax authorities and the
statistical agency would be considered relevant. However, in UEMOA countries this
definition is inadequate. In fact, the financial statements required even of formal firms differ,
with large enterprises reporting to the Division des Grandes Entreprises (DGE) in the
Treasury 5. Firms filing with the DGE have to provide more detailed financial statements than
do small enterprises. More importantly, many enterprises, especially the large informal
operators, are highly skilled at producing false financial statements. These firms are aided by
accounting firms that specialize in producing misleading accounting certificates. Many
informal actors admitted anonymously to us that they retain several versions of their accounts:
one for themselves, one for loan requests from a bank, one for tax authorities, etc. Each
version is created with a specific use in mind, and these firms have no trouble getting them all
certified by accounting firms complicit in this elaborate hoax. Accurate accounting is
therefore very difficult to determine. However, for want of a better alternative, we include this
criterion in our study as one component of a composite definition, classifying all firms that
are either not taxed at all or taxed on a lump-sum basis as being informal, and firms that are
taxed on a regular business income tax basis as being formal.
The mobility of workplace criterion
In West Africa many informal activities are highly mobile and without a fixed workplace.
This applies not only to travelling salesmen and street hawkers, but also mechanics,
carpenters, and small business owners. In general, these actors do not own or rent their
workplaces. Instead, they occupy unused spaces and vacate when the space is needed by its
owner. Given this situation, some researchers identify the informal sector with a lack of fixed
workplace. While it is true that many informal firms are highly mobile, many more informal
4
Organisation pour l’harmonisation des droits des affaires en Afrique is a regional setting empowered to design
rules and regulations applicable to businesses, which all UEMOA country members have adhered to.
5
Division des grandes enterprises. This is the tax division to which big firms, with a turnover exceeding a given
threshold (about CFA 1 billion) have to file to.
5
firms do have a fixed workplace, so this criterion identifies only a limited part of the informal
sector.
The access to bank credit criterion
Limited access to credit is also a characteristic of informality. Bank credit is largely an option
only for the formal sector while most small enterprises are confined to informal loans from
friends, family, or tontines, which all generally demand high interest rates (Johnson 2004;
Akoten et al. 2006). La Porta and Schleifer (2008) argue that informal actors’ limited access
to credit can be explained by their relatively low level of education. The criterion of access to
bank credit is very relevant to African countries. Banks demand a number of financial and
administrative documents before even examining loan applications. It is practically
impossible for informal actors to assemble the required documents. Nevertheless, this
criterion too has its limitations because many formal firms are also credit-constrained in
Africa. This is because lack of documentation is not the only constraint to obtaining credit.
Collateral requirements are also a major impediment; even some large firms are discouraged
from obtaining bank credit due to onerous collateral requirements as well as general reticence
of banks to lend to all but the largest and best-known businesses. There are many formal
enterprises, notably SMEs, which finance their investments with internal funds or through
informal financing with high, even exorbitant, interest rates. The access to bank credit
criterion, just like all preceding criteria, is relevant to informality but with limitations.
Our approach to defining informality
All the above criteria have some degree of validity suggesting that informality is better
described as a continuum defined by a combination of the above criteria. As Steel and
Snodgrass (2008) note, “…There is a continuum of different degrees of formality (in terms of
different characteristics such as nature of registration, payment of taxes, management
structure, contractual arrangements with employees, market orientation, etc.” The multicriteria approach was also used by Guha-Khasnobis and Kanbur (2006), who, when defining
informal employment, gave prominence to the absence of social security coverage; rights to
vacation; written contracts; low levels of revenue; lack of affiliation to a workers’
organization; unstable work conditions; and the illegal or quasi-illegal nature of the firm’s
activity. Although our focus is on informal businesses and not informal employment, we
retain many of the same criteria. Informality in the sub-region is a very complex reality that
varies enormously among different economic actors. Very few firms fit all the criteria of
formality. Therefore, we have distinguished between several levels of informality.
-- At the bottom of the ladder, there are those firms that are completely informal—
firms that do not fulfill any of the criteria defining formality. These firms are
completely unknown to fiscal authorities and all other administrations. They are small,
do not have access to bank credit, are not subject to the regular business income tax,
and are itinerant. These firms are at level 0 of informality.
-- The second level consists of those actors who fulfill at least one of the criteria
defining formality. This level includes mainly those who are registered with an
administration dealing with enterprises; who have more than 5 employees (or who
have sales of over 50 million CFA francs); or, finally, who have gained access to bank
credit within the previous 5 years. These actors are at level 1 of informality.
--At the third level, there are those actors that fulfill at least two of the five criteria
defining formality; at the fourth level there are those that fulfill three of the five
criteria, and so on.
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--The last level consist of formal firms who fulfill all five criteria of formality. These
firms are registered with at least one administration, employ more than five people or
have sales of over 50 million CFA francs, are taxed through the regular business
income tax, had access to bank credit within the past five months, and have a fixed
domicile.
Figure 1 : The above categories provide six levels of informality in increasing order, with
only a small proportion of firms that meet all of the criteria of the strict definition of formality.
Figure 2 Share of firms satisfying various criteria of informality
IV. Large informal businesses in West Africa
As mentioned earlier, a striking characteristic of West African informal sectors is the presence
of large actors that fulfill all the criteria for formality, but choose to stay in the informal sector.
The presence of this category of actors has been noted by other but rarely described and
analyzed in depth. For example, Jacobs (World Bank 2004) proposes a transition program
that allows firms near the margin to accede to the benefits of formality while taking on the
obligations gradually over time, but, referring to a West Africa case, he warns:
It should be clarified that the transition program for informal enterprises is not meant
to apply to those large-scale enterprises, particularly in the importing sector, that
evade taxes. These enterprises have no need for any special benefits. They exist only
with the tacit agreement of powerful supporters in the government, and their existence
should be considered a costly form of corruption rather than a special case for a
developing economy. To remedy this problem, the government needs to launch a
program to enforce the tax and the other laws against these enterprises.
Large informal firms are defined as those firms that pay the presumptive lump-sum tax while
having revenues above 20 million CFA francs per year (about $40,000). Large informal firms
are found in a variety of sectors in West Africa, including transport, industry, wholesale and
retail sectors, music distribution, etc. Data was obtained from different sources for formal,
large informal and small informal firms: for formal enterprises by consolidating files from
statistical services and fiscal services; for large informal enterprises from the fiscal services
file; for small informal enterprises from the 1.2.3 sample in each country, restricted to those
enterprises whose revenues are below 20 million CFA francs per year.
The analysis of the results of our interviews reveals some similarities, but many important
differences, between the large and small informal sectors. Many large informal firms do not
see themselves as informal; they are even offended at the suggestion that they might be
lumped into that category. In truth, they would not be classified as informal if the usual
criteria are applied mechanically. They appear, superficially, to meet most of the criteria
defining formality: they pay taxes; some even are taxed under the regular business tax regime;
their tax filings are handled by the DGE (the division that handles filings for large formal
firms mentioned above); have a high level of sales; have access to bank credit, etc. But a
closer examination reveals that their practices are in fact informal. Even though these firms
are large as measured by sales, their administrative structures are weak and resemble those of
small informal firms. Formal firms of the same size have distinct departments and a coherent
organizational structure, but informal firms do not. In fact, apart from the owner and a few
7
permanent employees (rarely more than five), the rest of the personnel are temporary. A
single individual manages the firm with little assistance from others. Managerial style is
similar to that of small informal firms. None of the usual departments in formal firms (sales,
input sourcing, finance, human resources, etc) exist in large informal firms, despite their high
levels of sales. Even the accounting function is outsourced to an independent firm, while all
medium-size formal firms have in-house accounting departments. In addition, the accounting
for these large informal firms is typically highly dishonest, massively underreporting sales
and profits. The absence of honest accounting is one of the determining features of the
informal sector, particularly for the large informal sector.
To provide some evidence on the magnitude of under-reporting of sales by the large informal
sector we carried out a comparison for Senegal of firm-level imports, reported by customs,
and sales as reported to the tax authorities for those same firms and recorded by the
government statistical agency. We selected a number of firms that paid the lump-sum
presumptive tax (in principle reserved for small informal firms). We considered only
importing firms with an identification number that allows their declared sales to be traced to
the fiscal agency. Given that most importing firms do not have an identification number (an
identifier is surprisingly not a requirement for importing), we were able to match only 132
firms in the fiscal and customs statistics, a small proportion of the firms that pay the
presumptive tax. Moreover, we were not able to identify the largest informal operators. Large
informal firms often have many identification numbers and fragment their imports, making it
difficult to determine their total imports. Indeed, of the 132 identification numbers whose
imports and sales we were able to cross-check, it would not be surprising if a good number
belonged to one individual.
Figure 3: proportion of firms under reporting sales to the tax authority by industry
Notwithstanding these limitations, our analysis starkly reveals the extent of under-reporting of
sales, demonstrating that many firms that are subject to a lump sum tax because of their
under-reporting of sales should actually be subject to regular business taxes. These false
declarations are facilitated by the lack of cooperation and exchange of data between customs
and the fiscal agency. The results show enormous gaps between imports and sales figures,
with imports sometimes 10 times greater than sales. While some imports are for capital goods,
the discrepancies are much too large to be explained this way, particularly given the largely
commercial nature of the activities concerned. Among firms in our sample, over 41 percent
report sales below imports. In certain sectors, like jewelry sales and mechanics, this
proportion is greater than 50 percent. In the retail sector, 56 percent of firms in our sample
have a greater value of imports than of sales! In fact, the discrepancies between imports and
reported sales may be even larger than Figure 7 suggests, given that imports can also be
understated by smuggling and underinvoicing.
The government officials we interviewed are well aware of this situation and acknowledged
that fraud is common. Joint squads of customs and tax agents identify a significant number of
fraudulent tax filings. When they identify tax evasion, they subject the firms to penalties and
regular business taxes. Often, however, these firms then declare bankruptcy or simply
disappear only to reappear under a different name and resume their practices.
The second phase of our survey, conducted in 2009, focused on large informal firms, largely
confirms that firms disappear when they are at risk of being discovered, or were discovered,
by the fiscal authorities. Many of the large informal firms identified in the first phase of the
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survey in 2007 had disappeared by 2009. For example, in Ouagadougou, only 30 percent of
large informal firms had survived, while for formal businesses the survival rate was 98
percent. This low survival rate of firms in the large informal sector is somewhat misleading,
however, as firms often closed and reappeared in a different form.
Although actors in large informal sector have access to bank credit, many of them continue to
make use of personal funds, or funds from their families or other personal relations. However,
this use of personal savings is a matter of choice rather than a necessity—these firms have all
the necessary documents required by banks for loans. Most of these documents are, of course,
fraudulent; but this would not be an impediment to access bank credit. These firms generally
eschew bank credit due to the onerous conditions of this credit and also because the resulting
increased transparency of their business income could increase exposure to the tax authorities.
The fragility of large informal firms’ distinguishes them from their formal counterparts.
Although proof is difficult, it is well known that these firms are engaged in fraudulent
activities. Also, their longevity is strongly linked to that of their owners; most firms
disintegrate after the death of the proprietor. Often, those who inherit the firm cannot come to
an agreement on how to operate the firm and it collapses. In other cases, a dramatic scandal
leads to the imprisonment of the owner of the firm. This has occurred in Senegal for several
large informal actors, including Cheikh Tall Dioum, Adel Korban, Khadim Bousso,
Moustapha Tall, (See Benjamin and Mbaye, 2010 for more details). In other cases, conflicts
with customs or with suppliers or creditors lead to the demise of the firm. Large informal
firms are like a giant with a clay foot. On the one hand, these firms operate on a large scale
comparable to that of firms in the formal sector. On the other hand, a simple disagreement
with a customs official can put an end to activities. These firms endanger themselves by
operating in the same manner as small informal firms, yet they have much greater visibility.
There is a constant battle between these firms and the fiscal authorities. Often these firms
benefit from political or religious connections, but this support itself can also be fragile and is
not unlimited. As soon as firms lose their political or marabout support, or are entangled in
incriminating public scandals, or cannot resolve a disagreement with customs, imprisonment
or the disappearance of the firm usually follows. Customs is particularly powerful in West
African countries, providing a major part of government revenues and also a locus of
corruption; when a conflict with customs officials arises, even well-connected informal actors
may have no choice but to compromise or go to jail.
V. The Informal Sector and the Institutional Environment
As noted earlier, firms opt for informal sector status in response to the perceived benefits and
costs of formalization. In Africa, it is quite clear the spread of the informal sector is fostered
by state failures, such as: the length and complexity of the registration procedures, the failures
of the judicial system, the weaknesses of structures responsible for collecting and delivering
support services to small businesses (including those of the informal sector), and the ability of
large influential players to circumvent the rules, often with the state’s compliance, etc. These
state failures interact with cultural traditions in West Africa to create an environment
conducive to informalization. For example, in Senegal, much of the informal sector is
connected to powerful Islamic religious groups, notably the Mourides. In this section, we
review some of these barriers to formality.
9
a. The business climate
The quality of public services (infrastructure, judiciary) affects the choices of firms insofar as
one of the benefits of formal sector status is greater access to these services; if these services
are of poor quality what is the point of being formal? Likewise if formal sector status requires
compliance with onerous regulations and high taxes, informal sector status is more appealing.
Most studies on obstacles to investment confirm that countries in the sub-region experience a
more adverse business environment than do other developing countries (see rankings from the
World Economic Forum’s World Competitiveness Report and the World Bank’s Doing
Business Indicators). Countries in West Africa are generally ranked well below those of the
other developing countries. Steel and Snodgrass (2008) conclude that in the African context,
getting registered and becoming formal are not advantageous for informal firms.
Our findings largely confirm the results of these surveys, but with certain nuanced differences.
Few enterprises saw registration as an obstacle. Of all the enterprises included in the second
phase of our study, which focused on formal and large informal firms, only 12 percent had
encountered obstacles in registering. Enterprises did, however, cite many other inadequacies
in public services.
The state’s failings in establishing credible policies to promote private-sector development
become obvious when heads of enterprises are asked about their taxation. Two thirds believe
that the state does not make good use of tax revenue, and this proportion rises to 88 percent
among medium-sized firms (enterprises with sales of between 50 and 100 million FCFA).
Furthermore, 69 percent of respondents believe that the state uses public funds unethically.
This proportion rises to almost 100 percent among medium size firms. Most firms also claim
that the state imposes excessive tax burdens on firms, leading to tax evasion. Many also agree
that they are exposed to even greater hassles if they formalize their firms. Among all
respondents in Senegal, 52 percent found that paying taxes exposes a firm to greater tax
hassles; 59 percent of large enterprises share this view.
A Senegalese tax agent explained the problem to us this way: “Informal actors are expensive
in terms of the research that we need to carry out to tax them.” Indeed, the fiscal
administrations of the three countries seem to be of the opinion that the cost of obtaining
information on informal firms outweighs the benefit of the increased revenues that would
result. Consequently they focus their efforts on the firms they can easily identify, and from
which they can collect the full amount of taxes due; in other words, formal actors. It is
obvious that this strategy, while understandable given the limited resources of the fiscal
authorities, creates important distortions. Most new business with the capacity to be formal
choose to seek refuge in the informal sector. In addition, existing formal firms are tempted to
migrate towards the informal sector to escape from fiscal hassles.
Most respondents have a negative view of the level of taxes and of the management of tax
collections. The majority thought that fiscal pressure was very high (60 percent of all firms
and 67 percent of large informal firms). In addition, 46 percent of respondents reported long
queues that made tax payment more difficult; 20 percent find it hard to declare taxes and 42
percent found the management of the collection service to be poor.
The state’s shortcomings in the application of laws and regulations also become evident when
respondents are asked about regulations relating to the informal sector. In Senegal, for
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example, 68 percent of interviewees find that the state does not adequately enforce regulations
concerning workers’ social security; the same proportion found inadequate verification of
honesty in revenue declarations and accounting. This high perception of lack of government
enforcement capabilities is one of the most important determinants of informality.
b. Corruption and difficulties in regulating large, influential actors
Corruption and failure to enforce rules and regulations are also major determinants of
informality. The corruption that exists in all rungs of society contributes to the flourishing of
large informal actors. Often, they are well connected politically, which offers them some
impunity. Court decisions are frequently challenged, and the press often reports corruption
scandals in the courts. Large informal actors are supported by a chain of collusion that
involves customs, the administration, and the courts. A customs authority from one of the
countries we visited confided to us that, “When we arrest a person for fraud, we quickly offer
him a deal and do our best to ensure that the case does not get to the tribunal or to the police;
once there, one is never sure what the outcome will be.”
Some large informal firms also rely on Islamic brotherhoods for support. Cross-border trade
between Senegal and The Gambia offers a good illustration. This trade has long been
dominated by well-identified social and religious groups, such as: the ‘baol baol’—traders
from the Mouride brotherhood—, Guineans, and Mauritians. Gambian importers of food
products (tomatoes, rice, tea, etc.) are linked to intermediate wholesalers who dominate the
distribution chain. The chain operates out of the Gambian urban centers of Banjul, Bakau,
Serekunda and Bassé, distributing imported products to shopkeepers installed along the
Senegalese border, where Senegalese smugglers go to stock up. Gambian importers also sell
directly to Senegalese traders, who come to Banjul or to Bassé with 35 ton trucks. Border
crossings of the goods can occur in two ways: either the truck is unloaded in a border
warehouse to allow small quantities of goods to be smuggled into Senegal, or the truck is
allowed to enter Senegal with the collusion of Senegalese customs agents. The Mouride
brotherhood plays an important role in this process. Mouridisme is based on clientelistic
relations that connect these business networks. The Mouride disciple proves his allegiance
and submission to his marabout (religious leader) by serving him in several ways, including
cultivating his land and offerings in kind and in cash. In return, the marabout offers protection
by intervening on behalf of disciples with the authorities, and through provision of an
informal social safety net and financial network. This allows Mouride traders from the
Senegalese cities of Prokhane and Kaolack to openly engage in smuggling products from The
Gambia. Before the privatization of peanut parastatal SONACOS and the dissolution of its
affiliate SONAGRAINES, registered traders who gathered peanuts for SONACOS would use
the advances intended for peanut cultivation to instead finance sugar, rice, and tomato
concentrate imports from The Gambia. Collusion between the Senegalese state and heads of
the Mourides has been well documented (see Golub and Mbaye, 2009). Notables in the
Mouride brotherhood receive special favors from the state. In 1986, after the partial
deregulation of rice imports, with 25 percent of the market allocated to private enterprises;
one of the largest transporters benefiting from the clientelistic allocation of market shares was
none other than the personal secretary to the Caliph of the Mourides.
VI. Productivity Differences Between Formal and Informal Firms
11
A large literature shows that there is a strong negative correlation between informality and
productivity of firms in developing countries. Steel and Snodgrass (2008) find that the
productivity differential between the two categories of firms is due mainly to unequal access
to public services. Gelb et al (2009) compare the productivity of formal firms and informal
firms using surveys on the investment climate for a number of countries of southern and
eastern Africa. Their results confirm that formal sector firms are on average more productive
than informal ones but the gap between formal and informal firms is much less for east
African countries than for southern African countries. They attribute this to the difference in
the quality of the quality of the business environment and the enforcement of rules. The
relative weakness of the state in East Africa undermines the performance of formal firms,
thereby lowering the gap between formal and formal firm productivity. La Porta and
Schleifer (2006) also find that the productivity level of informal sector firms is much less
important than that of formal sector firms. Their preferred explanation is differential access to
inputs (including human capital) and the difference in production scale. All these studies,
however, do not consider large informal firms.
To compare productivity levels between the formal and informal sectors, we compute two
alternative measures of productivity with our survey data: labor productivity and total factor
productivity (Harrigan 1996, Mbaye 2003, Mbaye and Golub 2003). Labor productivity (LP)
is measured using the following ratio:
Qi
, where Q is value added and L is the number of employees for firm i
Li
In order to measure total factor productivity (TFP), we use the Cobb-Douglas production
1.1. LPi =
function:
, where K is capital stock and α and β are the respective shares of
labor and capital in total factor income.
1.2. TFPi =
Qi
=A
Li K i β
α
Under the usual assumption of constant returns to scale we have α + β = 1. TFP can be
estimated using a log-linear version of the Cobb-Douglas production function:
1.3. LogQ = A + αLogL + βLogK + ε
Total factor productivity is computed as the constant term in Equation 1.3. Equation 1.3 was
run separately for each of the three subgroups in our sample (formal, large informal, and small
informal sectors). This provides measures of average TFP for the various firms in the three
categories, assuming that the production functions for the individual firms are of the CobbDouglas type with constant returns to scale. Alternatively, equation 1.2 can be used to
evaluate TFP at the firm level, without requiring the assumption of common production
functions.
LP and TFP are related as follows:
1.4
ALα K β
K
LP =
= A 
L
L
β
12
1.5
 Kt


 LPt 
 TFPt 
Lt 
 = ln
 + β ln

ln
K
LP
TFP
t
−
1


t −1 
 t −1 


Lt −1 

Recall that β represents the capital share of income.
Equation 1.4 indicates that labor productivity is a function of TFP and capital intensity, while
1.5 shows the same relationship in rates in change. A rise in capital intensity will lead to a rise
in LP, holding A constant. These equations suggest that productivity differentials between
sectors could be due either to efficiency/technological differences (A) or differences in
capital-labor ratios. Differences in capital-labor ratios could in turn reflect differential access
to financing between formal and informal firms, or between large and small firms. Our
results indicate that productivity differences between formal and informal firms reflect
differences in both efficiency and capital intensity.
Equations 1.1 through 1.5 are estimated using data collected from 900 firms in three West
African capital cities (300 in each city): Cotonou, Dakar, and Ouagadougou. 6 We compute
productivity both by degrees of informality and for the three groups of firms: formal
enterprises, and large and small informal enterprises (as defined in section IV, page 7 above).
Our results confirm a significant productivity gap between the formal and informal sectors of
the three cities, but the gap is much smaller for the large informal sector. Labor productivity is
higher on average in formal firms than it is in the large informal firms, which in turn have
higher labor productivity than small informal firms. Figure 4 displays boxplots showing the
distribution of productivity levels by degrees of informality. Productivity gaps are found to be
more pronounced in Ouagadougou. This particularly large discrepancy in Ougadougou is
likely to be related to firms’ perception of the business environment, which is considerably
better in Burkina Faso. Whether one considers access to basic social services, the amount of
time necessary to obtain access to these services, or average duration of service disruptions,
the results of our survey indicate that the situation on Ouagadougou is far more favorable than
those of the other cities. This lends credence to the hypothesis proposed by Gelb et al. (2009)
that the two most important determinants of the productivity differential between the formal
and informal sectors are the quality of the business environment, and the ability of the state to
establish and enforce laws and regulations.
Formal firms account for the bulk of firms with the highest labor productivity levels, whereas
informal firms constitute a large majority of firms with low productivity. For example, in the
case of Senegal, among the companies with a productivity level between 100 million and 300
million CFA francs CFA francs per worker, 77 percent are in the formal sector, with 23
percent and 0 percent in the large and small informal sectors respectively. Conversely, among
the firms with productivity levels below 5 million CFA francs, only 13 percent are in the
formal sector, while 7 percent are in the large informal and the remaining 80 percent are in the
6
Because most of our regressions are logistic, no simple formula is available to determine which error might
-- (the
occur on coefficients in the model, but a rough approximation can be obtained as proportional to
proportionality constant will depend on a number of factors), assuming that the sample is a simple random
sample of the population (in reality, because we are using stratified sampling, errors will be somewhat less).
This means that we can see how much improvement can be obtained by increasing the sample size to 400, 500,
etc in the table below. Improvements to the precision of estimates increase quite slowly with sample size. This
consideration plus the fact that a sample size of 300 is practically feasible led us to this choice of sample size.
13
small informal. If we consider a productivity level threshold of 50 million CFA francs, only 8
percent of all the firms surveyed in Senegal achieve a level of productivity above this
benchmark, while this is the case for 23 percent, 20 percent, and 0 percent for the formal,
large informal, and small informal sectors, respectively.
We were also interested in the magnitude of productivity gaps between the three subgroups of
our sample (formal, large and small informal). As it turns out, productivity differential is
actually relatively small between the formal and large informal sectors, whereas the gaps
between either of those subgroups and the small informal are quite pronounced. For example,
in Senegal, 22 percent of the firms in the formal sector and 21 percent of firms in the large
informal sector achieve productivity levels superior to 50 million CFA francs, but no firms in
the small informal sector do so. However, if one looks at higher productivity levels, the
differences between the formal and large informal sectors are clearer. For example, in Senegal,
17 percent of formal sector firms have productivity levels which exceed 100 million CFA
francs, as compared to only 10 percent of firms in the large informal sector.
Figure 5 : Firm distribution according to informality and level of
productivity in Dakar, Ouaga and Cotonou
These productivity differences are robust to alternative indicators or correlates of informality.
For example, firms which offer their employees social security coverage (i.e., mainly formal
firms) have markedly higher productivity than those which do not offer such coverage. Thus,
among firms with productivity levels below 5 million CFA francs, 76 percent offer no social
insurance coverage for employees. Conversely, among firms that achieve a productivity level
superior to CFA 300 millions, 75 percent have a social security coverage, while the remainder
certainly belonging to the large informal 7 does not have it. Access to bank credit is correlated
with productivity although less so than other factors: among firms with productivity levels
below 5 million CFA francs, 84 percent had not received bank credit within the past 5 years,
while for firms with high productivity (between 100 and 300 million CFA francs) the rate
drops to a still rather-high 62 percent (Figure 5). A firm’s failure to keep systematic and
accurate accounts is strongly associated with productivity levels: 46 percent of companies
with low productivity levels (less than 5 million CFA francs) do not keep regularly updated
accounts, as compared to 92 percent firms with higher productivity levels (100 million – 300
million CFA francs). The story is similar when we consider formal registration: 100 percent
of firms with productivity levels exceeding 50 million CFA francs were registered, as
opposed to 86 percent of firms with productivity levels below 50 million CFA francs (Figure
3).
To test the impact of informal status on productivity more fully, a simple OLS regression is
used. The dependant variable is the log of labor productivity, which is regressed on a variety
of sets of explanatory variables such as informality, the characteristics of corporate managers,
the sectors in which the firms operate, as well as their perceptions of the business
environment and the labor market. Using the stepwise backward procedure, we proceeded to
eliminate certain variables in order to retain only the most significant. The results obtained
with our baseline regression are presented in Table 1. Our results indicate that all variables are
significant with the expected sign. Informality is here considered as a categorical variable
7
By definition, no small informal firm can achieve a level of turnover, and thus a level of productivity above this
threshold.
14
which takes on the values 1, 2, and 3, respectively for the large informal, the formal, and the
small informal sectors. The formal is considered here to be the reference variable and is
dropped. The form3 variable which represents the small informal has a negative coefficient
which is significant at the 1 percent level, while the form2 variable for the large informal
sector has a positive coefficient significant at the 1 percent level. Other factors involved in
determining labor productivity are capital intensity (positive and significant at 1 percent) and
the firm’s industry affiliation.
There are three potential problems, which could bias the results of our regressions:
a) a careful examination of our data indicates that most variables are not normally
distributed and many have highly skewed distributions;
b) a non-linear specifications might yield superior results;
c) while our descriptive statistics, along with the results obtained from our basic
regression, indicate a negative correlation between informality and productivity,
this does not indicate the direction of causation; bidirectional causality between
these two variables could induce endogeneity bias.
To address questions a) and b), we used the CART method (Classification and Regression
Trees), a non-parametric relational analysis method. Informal versus formal sector status
emerges as the variable which best splits labor productivity observations into two distinct
groups. This result is valid for all three cities (Cotonou, Dakar, and Ouagadougou), and
unambiguously indicates the decisive connection between informality and firm productivity.
Moreover, the CART analysis allocates the large informal and formal sectors together into
one homogenous group, while the small informal is placed into a separate group. The gap in
the average log productivity between the grouped formal and large informal sectors relative to
the small informal is 2.09, 1.93, and 2.89 for Dakar, Cotonou, and Ouagadougou respectively.
In addition to informal sector classification, other factors also affect labor productivity
according to the CART analysis, namely industry in which the firm operates, firm size, and
capital intensity. These findings are quite consistent with the findings from our regressions
and the descriptive statistics. However, there seemed to be strong correlations between certain
explanatory variables, particularly industry and size. We therefore interacted these two
variables in a second model, the results of which are presented in Table 2. This new
specification improved the results while confirming the main findings. Capital intensity is still
significant at 1 percent, with the expected positive sign. The coefficient on form3, which
represents the small informal sector, remains significant at 1 percent with negative sign.
Industry classification is also significant, most notably affiliation with trade and service
sectors. The R-squared statistic also improved. In order to address whether or not the
existence of a bidirectional relationship could cause residuals to be correlated with
explanatory variables, most econometrics textbooks recommend the use of estimation with
instrumental variables. However, we refrained from searching for appropriate instruments in
view of recent research which casts doubt on the validity of instrumental variable procedures
and their alleged superiority over OLS methods (Murray 2005, Larcker and Rusticus, 2005).
Conclusion
In this paper we have reported on research on the informal sector in West Africa, using survey
data from Benin, Burkina Faso and Senegal. The sampling strategy we have used in this study
differs significantly from those used in most other studies which are often based on a narrow
definition of informality focusing on size as the major distinctive feature of informality. We
15
have instead relied on an approach to informality which combines a spectrum of criteria
identifying informal firms. These survey data are used along with other qualitative data
gathered from semi-structured interviews and secondary data from the national income
accounts. One major novelty of our study is the inclusion of large informal firms which
coexists with the more well-known small informal firms. Large informal operators often
operate thanks to political connections and rely on bribery, corruption, and fraud in an
environment where the business climate is adverse and state enforcement of regulations is
very weak.
A particular focus of this study is the relationship between informality and productivity. Our
results confirm the heterogeneity of the informal sector. Specifically, they confirm the
importance of distinguishing between the large and the small informal firms in describing
behavior and identifying obstacles in the investment climate. The productivity gap between
formal and informal firms is found to be important for small informal businesses but much
less so for large informal ones.
Policy recommendations differ for dealing with large and small informal enterprises. The
informal sector is a symptom of institutional deficiencies, and the prevalence of large
informal firms, in particular, reflects government failure to enforce regulations, as well as the
burdensome nature of regulations and taxation that inhibit compliance. For these large
informal firms for which formalization is feasible, regulations and taxation should be more
systematically applied and enforced. For smaller informal firms, improvements in support
services and easing of burdensome regulations are in order. Governments should
systematically test regulations to make sure that social benefits outweigh enforcement and
compliance costs.
16
Figure 1: Informality as a continuum : the six different levels of formality
Figure 2 : Share of firms failing to meet various criteria of formality
17
Figure 3: Proportion of firms under-reporting sales to the tax authority by industry: imports >
total turnover
0
productivite
2.0e+07
4.0e+07
6.0e+07
Figure 4 : Correlation between productivity and informality in Dakar and Ouagadougou
Dakar
0
1
2
3
4
Ouagadougou
18
5
6.0e+07
productivite
2.0e+07
4.0e+07
0
0
1
2
3
4
5
Figure 5: Firm distribution according to informality and level of
productivity in Dakar, Ouagadougou and Cotonou
Table 1 : Estimation of productivity equation (lprod)
Lprod
Coef.
Std.Err. t
P>|t| [95% Conf.Interval]
Capital labor
ratio
0,096
0,027
3,550
0,000
0,043
0,149
services
0,463
0,218
2,130
0,034
0,035
0,891
trade
0,836
0,220
3,790
0,000
0,402
1,270
buildings
0,709
0,425
1,670
0,097
-0,128
1,546
Legal structure
0,606
0,340
1,780
0,076
-0,064
1,275
Small informal
-1,401
0,239
-5,860
0,000
-1,872
-0,930
Big informal
0,658
0,295
2,230
0,027
0,077
1,239
_cons
13,054
0,521 25,050
0,000
12,028
14,080
Number of obs =286 ; F( 7, 278) = 22,05 ; Prob > F = 0 ; R-squared = 0,36
19
Table 2 : Estimation of productivity equation making sector and formality status
variables interact
Lprod
Coef. Std.Err T
P>|t|
[95% Conf.Interval]
Capital labor ratio
0,100
0,027
3,720
0,000
0,047
0,153
Small
informal*financial
services
2,362
1,401
1,690
0,093
-0,395
5,119
buildings
0,706
0,423
1,670
0,096
-0,126
1,538
Big
informal*commerce
-1,298
0,594 -2,190
0,030
-2,468
-0,129
Small informal
-1,090
0,278 -3,920
0,000
-1,638
-0,543
Small
informal*commerce
-1,056
0,471 -2,240
0,026
-1,984
-0,129
Big informal
1,086
0,364
2,990
0,003
0,371
1,802
services
0,499
0,216
2,310
0,022
0,073
0,925
Legal structure
0,761
0,342
2,220
0,027
0,087
1,434
commerce
1,788
0,440
4,070
0,000
0,922
2,654
_cons
12,694
0,530 23,930
0,000
11,650
13,738
Number of obs = 286 ; F( 10, 275) = 16,67 ; Prob > F = 0; R-squared = 0,38
20
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